Acquisition of Avenue Therapeutics to be Credit Neutral for Cipla

New Delhi, December 18, 2018: India Ratings and Research (Ind-Ra) believes that Cipla Limited’s (IND AAA/Stable) proposed acquisition of the US-based Avenue Therapeutics Inc. (Avenue) through its US-based subsidiary InvaGen Inc. would not materially impact its ratings. Ind- Ra had factored in Cipla’s USD500 million debt-funded, EBITDA neutral acquisition-related cash outflows over FY19-FY20 while reviewing the ratings in October 2018. The acquisition is well within the agency’s expectation.

De-risked Acquisition Structure: The agency believes the announced acquisition is adequately de-risked by way of a deferred payout structure based on the successful filing, regulatory approval and commercialisation of Avenue’s flagship product intravenous Tramadol (IV Tramadol). Cipla expects to pay USD215 million in two tranches; USD35 million upfront for a 33.3% equity stake and USD180 million for the balance equity stake subject to statutory and regulatory approvals. The first tranche is expected to be funded by internal accruals and the second tranche could be funded by a mix of debt and internal accruals.

The deferred payout structure addresses the risks associated with the progress of clinical trials for IV Tramadol as well as the demonstration of commercial potential of the opportunity. Avenue is evaluating IV Tramadol in a Phase 3 clinical programme, and expects to submit the 505(b) (2) application for the drug to the United States Food & Drug Administration by end-2019.

US Institutional Franchise to Benefit: According to Avenue, IV Tramadol may fill the gap in the acute pain market between IV Acetaminophen/non-steroidal anti-inflammatory drugs and intravenous conventional narcotics. The acquisition would enable Cipla to establish its presence in the specialty institutional (hospital) business in the US, which is characterised by high entry barriers due to sterile manufacturing, faces low price erosion and thus earns high margins.

Credit Profile Intact, Adequate Headroom: Tramadol IV is a R&D asset and has no commercial sales. Over 2015-YTD 2018, Avenue has spent USD28.2 million on R&D, using initial public offering proceeds and support from the parent Fortress Biotech, Inc and is a debt-free company. Avenue is likely to incur additional R&D expense in 4Q18-2020 for the phase III programme and post approval market study, which is likely to be funded by Cipla. The agency expects Cipla’s adjusted net debt/EBITDA to be below 1.5x at end-FY19 (end-September 2018: 1.4x; FY18: 1.3x). Cipla’s business risk profile continues to be supported by its strong domestic competitive position and improving competitive position in the US markets, reflected by product rationalisation initiatives and proposed launch of complex generics. The agency expects adequate cash flow generation to aid in absorbing the impact of the acquisition over FY19-FY21 and maintaining a comfortable credit profile.

Integration Risks: The integration depends upon Cipla’s ability to ramp-up commercial IV Tramadol sales. The drug is likely to compete with conventional pain management products and R&D assets. Also, there exists regulatory uncertainty regarding restrictive opoid usage in the US markets and supplier concentration for commercial supplies. The agency draws comfort from the low abuse potential of oral Tramadol and its classification as Schedule IV controlled substance by United States Drug Enforcement Administration in July 2014. Furthermore, As per IMS health, IV Tramadol accounts for about 10% of IV analgesics used in Europe in 2014-2016, indicating demonstrated clinical acceptance in other geographies.

Adequate Liquidity, Modest Refinancing Risk: Cipla has large debt repayments over FY20-FY22. The agency expects the company’s cash balances & liquid investments of INR24 billion at September-2018 and healthy cash flow generation to support the acquisition outflow and debt repayments over FY20-FY22. Also, Cipla has adequate unutilised working capital lines. However, incremental debt-funded acquisitions may lead to moderate refinancing risks and delay deleveraging.

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